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Brace Yourself for Election-Driven Enforcement Theater: Token Roughing Up of Crisis Bad Banksters, While Corzine Gets a Free Pass

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It’s bad enough that we are being subjected to relentless propaganda about how housing is just about to turn the corner and the state-Federal mortgage settlement is such a great deal for homeowners. In fact, as we’ve stressed, and bond investors such as Pimco have reiterated, the deal is above all a back door bailout of the banks. Bloomberg weighed in yesterday:

Bank of America Corp., Wells Fargo & Co. and three other banks that settled a nationwide probe of foreclosure practices this month will get a bonus from the deal: protection for $308 billion of home-equity loans they hold…

It’s “a gift to the banks, at investors’ expense,” said Goodman, a member of the Fixed Income Analysts Society’s Hall of Fame. “A proportionate write-down of the first and second represents a reversal of normal lien priority.”

But to add insult to injury, the chump public will be given bread and circuses enforcement theater to distract it from the fact that the banks are getting a sweetheart deal.

The show is already on the road. The Financial Times tells us that Wells Fargo and Goldman have reported that they have received so-called Wells notices, which is an advanced warning that the SEC staff plans to file civil charges. SEC is pursing firms that it believes misrepresented the quality of loans that were bundled and sold as mortgage backed securities.

This all sounds great, right? Wrong. Take a look at your calendar.

The toxic phase of subprime issuance started in the late summer-early fall of 2005 and screeched to a halt in June 2007. But the statute of limitations for securities liability is five years. So the ONLY deals the SEC can pursue now are the last gasp transactions of March- June 2007, and on those, the clock is ticking. Those were particularly dreadful and no doubt would provide some colorful anecdotes, but who are we kidding? The SEC has sat on its hands until an election year need to Look Tough will lead to a filing of a few random lawsuits to rough up the usual suspects. But the reality is that the horses have left the barn and are now in the next county.

Contrast this with the flailing about on MF Global. From the New York Times, emphasis ours:

Federal authorities are struggling to find evidence to support a criminal case stemming from the collapse of MF Global, even after a federal grand jury in Chicago has issued subpoenas.

Investigators, unable to find a smoking gun amid thousands of e-mails and documents, increasingly suspect that chaos and poor risk control systems prompted the disappearance of more than $1 billion in customer money, according to several people involved in the case.

Have none of these people heard of Sarbanes Oxley? This sort of failure falls right in its crosshairs. As we wrote a year ago:

Contrary to prevailing propaganda, there is a fairly straightforward case that could be launched against the CEOs and CFOs of pretty much every US bank with major trading operations. I’ll call them “dealer banks” or “Wall Street firms” to distinguish them from very big but largely traditional commercial banks like US Bank.

Since Sarbanes Oxley became law in 2002, Sections 302, 404, and 906 of that act have required these executives to establish and maintain adequate systems of internal control within their companies. In addition, they must regularly test such controls to see that they are adequate and report their findings to shareholders (through SEC reports on Form 10-Q and 10-K) and their independent accountants. “Knowingly” making false section 906 certifications is subject to fines of up to $1 million and imprisonment of up to ten years; “willful” violators face fines of up to $5 million and jail time of up to 20 years.

The responsible officers must certify that, among other things, they:

(A) are responsible for establishing and maintaining internal controls;
(B) have designed such internal controls to ensure that material information relating to the issuer and its consolidated subsidiaries is made known to such officers by others within those entities, particularly during the period in which the periodic reports are being prepared;
(C) have evaluated the effectiveness of the issuer’s internal controls as of a date within 90 days prior to the report; and
(D) have presented in the report their conclusions about the effectiveness of their internal controls based on their evaluation as of that date;

These officers must also have disclosed to the issuer’s auditors and the audit committee of the board of directors (or persons fulfilling the equivalent function):

(A) all significant deficiencies in the design or operation of internal controls which could adversely affect the issuer’s ability to record, process, summarize, and report financial
data and have identified for the issuer’s auditors any material weaknesses in internal controls; and
(B) any fraud, whether or not material, that involves management or other employees who have a significant role in the issuer’s internal controls

The premise of this requirement was to give assurance to investors as to (i) the integrity of the company’s financial reports and (ii) there were no big risks that the company was taking that it had not disclosed to investors.

This section puts those signing the certifications, which is at a minimum the CEO and the CFO, on the hook for both the adequacy of internal controls around financial reporting (to be precise) and the accuracy of reporting to public investors about them. Internal controls for a bank with major trading operations would include financial reporting and risk management.

It’s almost certain that you can’t have an adequate system of internal controls if you all of a sudden drop multi-billion dollar loss bombs on investors out of nowhere. Banks are not supposed to gamble with depositors’ and investors’ money like an out-of-luck punter at a racetrack. It’s pretty clear many of the banks who went to the wall or had to be bailed out because they were too big to fail, and I’ll toss AIG in here as well, had no idea they were betting the farm every day with the risks they were taking.

The nice thing about Sarbox is a lower risk civil filing can lead directly to a criminal case on the same issues. And based solely on news reports, there seem to be at least two general routes that could be pursued with MF Global. The first is the abject risk management failure that got them in the mess in the first place, the infamous “repo to maturity” trade on short-term Italian government debt. The fact that this was Corzine’s trade, and that he levered it up, and had no apparent understanding that it would be subject to a collateral posting requirement if the price of the debt move against him by more than 5% is managerial incompetence. Either MF Global’s risk management systems were deficient (which means his Sarbox certifications were false) or he overrode them, making them deficient (the fact that he got rid of one manager who insisted on briefing the board about the trade and reduced the independence of his successor supports that idea).

Second is the customer funds that went poof. This has never never never happened to a broker dealer or commodities broker ex fraud. Even in Refco’s embezzlement, accounts were transferred to new firms without a hitch. The media has repeatedly discussed how the staff was not sure of what was happening in the panic to save the firm. I’m sorry, but other firms have faced liquidity crises and the resulting high trading volumes as customers closed out trades and accounts without “accidentally” pilfering customer funds (start with Bear, which went down in a mere ten days). A trading firm needs to be robust enough to handle market turmoil and panicked trading and unexpected calls for collateral, both from a balance sheet and systems standpoint; that should be obvious after September-Octover 2008.

If no one can make an argument for prosecution on deficient controls using Sarbox in a case this egregious, that’s because no one is trying very hard. And that is no surprise.

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35 comments

  1. vlade

    About year and a half ago I talked to a senior Republican. He kept claiming that “unfortunately” there was no way anyone could sue banks/Lehman. When I said how come when you have SarbOx, he shut up and tried to move the conversation in an entirely different way.

    What I’d like to know, is whether any of the people in Occupy happened (say as L. employees) any L shares. Could they then, in theory, sue under SarbOx privately? If so, then OWS could raise some money to pay good lawyers & start the process rolling.

    I wonder whether you could do the same with servicers/RMBS issuers if you know that your pension fund was/is invested in the ones that will take the hit due to the mortgage deal – and even sue govt under unconstitutional misappropriation of property.

    If the state is not willing to sue, we’d find someone who is (and can). Or am I missing something and no private lawsuits can be started?

    1. Capo Regime

      You or anybody can start all the lawsuits you want–so what? You have a few millions you want to put down a rathole of civil litigation that goes nowhere? Economists do not understand the financial system and 99% of Americans do not understand the legal system and are under the illusion that its some instrurment of justice per high school civics and a jimmy stewart movie.

      1. CIA Broom Closet Attendant 101

        Exactly. I worked for years under some real estate investors selling American cities/buildings, ect. and was still dense as to why the Federal officials who came late after work always brought big suitcases and the corner office multi-millionaire would draw the curtains. So stupid was I. Years ago. Foreign investors, Arabs, Japanese, Germans and I would get a lot of mail for a certain guy from some “Heritage Foundation” that wasn’t even in the news yet. Of course they closed up shop after the certain cities labor-class neighborhoods were transformed and upscaled. I see the wife occasionally in society pages but she prefers Dubai. And they were always talking about this Kravis Kolberg Group a building over. Jealous and admiring at the same time. But of course all that is “private history”.
        The slaves, have movies, and nice fairy tales to sleep with.

    2. James Cole

      The legal theory you are referring to is “unconstitutional taking of property” also known as “inverse condemnation.” I don’t know enough about the technical legal aspects of the settlement to see whether this is a “taking” or not (because it appears to be consensual), which raises the question of how as a technical matter this will be accomplished. I am guessing that the servicers themselves are going to act on behalf of the noteholders and sign the papers that effect the actual write-downs, so there is potentially a point of attack in that MBS trustees (as the noteholders) can challenge the servicers’ actions as unauthorized under the servicing agreements–but the problem there is that, even if this claim is supported by the servicing agreements (a big if), due to the underlying fact that the paperwork on these deals is a mess MBS trustees (a) will have a hard time figuring out if any particular mortgage is in a particular trust and (b) aren’t going to act anyway because they are conflicted, being either affiliates of the second-lien holders or dependent on originating banks for business, as BNY is with respect to BofA.

      I would venture a guess that some of the larger funds such as PIMCO’s total return fund (PTRXX) hold MBS that are being impacted by what amounts to a cram-down of senior mortgage lienholders in favor of junior home-equity line lenders. The problem is that angry humans like you and me that happen to be shareholders of PTRXX (for example) have no direct contractual link to the servicers, we would have to rely on moral persuasion to get PIMCO to act, PIMCO would have to try to get information (which may be missing or nonexistent) from the MBS trustees about the extent to which particular MBS are impacted by the improper subordination brought about by the settlement, and then PIMCO would have to compel or persuade the trustees of the MBS to act (who are conflicted) against the servicers to enjoin the subordination and go to court.

      To say that the barriers to enforcement are high is an understatement, unfortunately, but I volunteer to help put together a campaign of some sort to kick off the first step here, which is urging PIMCO (or similar fund) to act.

      1. vlade

        Thanks for that – I agree that the barriers are high, but that doesn’t necessarily mean it should be looked at.

        I haven’t seen the details of the agreement (I don’t know if anyone did it in full yet.. ), but if it’s consensual (i.e. tha banks acting as trustees will sing off the release of bank liable to the trusts), I’d go after the trustees for breach of fiducary duties. It’s way over my paygrade, but I’d assume that the precedent here is well established. In addition to that, some of the trustees are likely to be UK domiciled funds, so you could sue them under breach-of-duties (and I believe UK courts are considerably less stuffed in this than US ones – if nothing else, they don’t have a political ax to grind).

        I’d expect that on something like that the trustees would have to establish that making second liens pari passu with first liens was beneficial to the first-lien holders (i.e. the RMBS holders), which would be quite a bit of magic. The only possible avenue I could see for them would be to argue that any court costs would be significantly higher than the losses realised – so beneficial in the sense of less harmful. Although I could see this more as an out for PIMCO or investment managers rather than the note trustees (that is, for trustees to preserve the value takes no action – don’t sign – and destroy value takes action – sign. for PIMCO it’s opposite – they have to sue to retain value).

        Of course, as you say, that could all open the can of trust-doesn’t-have-the-notes in the first place, but that still fall under dereliction of fiducary duties.

        How about buying an actual RMBS note (min issuance tends to be around 100k) before the agreement goes live and then suing the trustees? Rediscovering the old “we’re now shareholders, you have to listen to us” trick? Might be a bit too late for that I guess…

      2. Capo Regime

        I can assure you that if it were in PIMCO’s interest to act they would do so without you prompting them.

    3. falun bong

      Legal fees *so far* on Lehman exceed $2 billion.
      Historians will write about this collapse of the rule of law in the US as a major turning point. Between MFG and the robo “settlement”, put a fork in it.
      I now trade futures only in Hong Kong. Who would have thought that to get a credible regulatory regime, reliable contract law enforcement, and transparency I would have to go to *communist China*
      Chronicling the tragic decline of the once free, once great, once rich nation of America is depressing…

      1. Francois T

        “I now trade futures only in Hong Kong.”

        Do you know a lot of traders who have done likewise for the same reasons, ie. lack of respect for rule of law in US?

  2. rafael bolero

    Yes, no rule of law here anymore, just law theater. Yesterday a judge ruled it is okay for Monsanto to sue organic farmers into whose fields winds bring Monsanto’s GMO pollen or seed, for copyright violation, or theft. I am sure the SCOTUS will rule no one (Nigerians, in this case) can sue a US corp. for foreign crimes under the 1794 TORT: the constitution, and bill of rights, and the legal system we had just 10 years ago are gone. This financial fraud OK is the same brand of wild-west plunder. This place is being trashed and looted, and the laws are gone. Obama might as well be tap dancing in black face to distract the crowd.

    1. Fraud Guy- Also

      I think you distorted the facts here about the Monsanto case. The organic farmers were suing Monsanto to invalidate their GMO patents, based on arguments that included the hypothetical scenario that the organic farmers could be sued for infringement if Monsanto GMO seeds cross-pollinated the organic fields. While I am very sympathetic to the idea that gene patents for seeds (particularly those that include so-called Terminator genes) are against public policy, I don’t think this case’s dismissal is a particular example of corporate lawlessness. Legal protection for the Terminator function, I would agree, is an abuse of the law. Organic Seed Growers & Trade Association v. Monsanto Co., 11-02163, U.S. District Court, Southern District of New York (Manhattan)

      1. VJBinCT

        My best analogy to the Monsanto-organic farmers situation is that of a gunman (Monsanto) shooting at a farmer running in fear of his life. The farmer catches a bullet in the back; the gunman presses charges against the farmer for stealing the bullet.

  3. fresno dan

    If the US collapses, I believe history will say the sterling example of the end of rule of law was epitomized by the lack of prosecution of Jon Corzine

    1. Capo Regime

      “if the U.S. collapses”. there are an abundance of signs/indicators that the u.s. has already collapsed. I suppose it is a function of what one means by collapse. What is the baseline? When was the U.S. a reasonably transparent and honest country? Maybe in 1972? 1956? 1984? Seems there was always some crisis and a lot of bullshit to justify interventions which enriched somebody well connected–always. Who is to say, perhaps we were always a bit transgressive but now things have gotten way out of hand or we are just more aware–internet, things move faster, 300 news channels, international travel and so more masses are aware of corruption just like more are aware of fashion in France. I would venture that it all got worse in small things. Any visit to family court, tax court, hearing of people go to jail for $250 credit card bill, denying a job due to a ding in the credit report, and so forth changes your perspective on “american justice” and well nothing will surprise you any more.

    2. Maximilien

      I agree completely. The MF Global bankruptcy was a watershed moment in the history of financial crime. Flagrant, blatant, undisguised, and shameless looting. Probably conducted in accordance with a contingency plan and apparently carried out with no fear of legal consequences. In the minds of MF’s executives the rule of law seemed no longer to exist. In the event, they have been proven right.

      On October 31, 2011 (the day of its bankruptcy), all of its offices should have been swarmed by investigators and wrapped in yellow crime scene tape. Instead—nothing. On that day it finally became crystal-clear that America had become the founding fathers’ worst nightmare: a nation ruled not by laws but by men.

      The men who now stand in place of the laws have left Corzine The Criminal free and untouched for 121 days. And counting.

  4. Fraud Guy- Also

    When the SEC’s lawsuits are actually filed, do you think the MSM will mention that the statute of limitations already expired on all but the last couple of months of dodgy securitizations before the SEC got around to acting? Don’t hold your breath.

  5. SR6719

    Yves: “..to add insult to injury, the chump public will be given bread and circuses enforcement theater to distract it from the fact that the banks are getting a sweetheart deal…Contrast this with the flailing about on MF Global.”

    Paraphrasing Hunter S. Thompson, how much of this cheap-jack bullsh*t can we be expected to take? If there were any true justice in this world, then Corzine’s rancid carcass would be somewhere around Easter Island right now, in the belly of a hammerhead shark.

  6. brian

    eventually you will see more and more acts of apparent random domestic terrorism and crime carried out by homegrowns
    its the only remedy people who are pushed up against the wall will have even if it means their own death

    that’s why preventative detention without charges or trial is so important to the government

    a tool to maintain some order at all costs

    fortunately my ashes will be in an urn by then

    1. problem is

      You mean the FBI has found more mentally ill patsies to give money, plans, weapons/bombs (real or fake) and rides to the crime locations…

      So the FBI can pounce on their own set up patsies and save Amerika??

  7. Fraud Guy- Also

    According to today’s WSJ, the GS offering that the SEC has filed a Wells notice on is from 2006. Yves says that the statute of limitations should have already expired on this, so something is inconsistent. Could it be the case that the SEC can put a potential defendant on notice before the statute of limitations expires and thus preserve its rights to file suit later, beyond the nominal expiration of the statute of limitations?

    From the WSJ:

    In its annual report filed with the SEC on Tuesday, Goldman said it received on Feb. 24 a Wells notice from the Securities and Exchange Commission related to disclosures in sales materials for $1.3 billion of subprime-mortgage-backed bonds. The bonds were sold in 2006.

    http://online.wsj.com/article/SB10001424052970204653604577251832810283876.html?mod=WSJ_article_comments#articleTabs%3Darticle

    1. Dean

      Vacuus ordinatio, nusquam.

      vacuus: without, useless

      ordinatio: rule, government, order, arrangment, regulation.

      nusquam: nowhere, in no place, nothing, for nothing, never.

    2. Yves Smith Post author

      Please reread post. I said securities law claims.

      There are other theories under which the SEC could sue, but they have a MUCH higher barrier of proof for fraud. With securities law claims you just have to show that the offering documents were inaccurate or incomplete in a material fashion (this is not the exact SEC language but this is pretty much the concept). With most other theories, you have to show intent. Now maybe they found some juicy e-mails or have someone involved in the origination who is acting as a whistleblower and thought these particular deals were such a slam dunk that they decided to go with them.

      This also may well be a late 2006 deal and there may be a technical reason that they can file a suit a bit beyond the five years if they do file a suit (as in they were investigating).

  8. El Snarko

    Two big things: When Americas business is business, profit is law. What is Latin for “Without regulation nothing”? This needs T-shirts.

    Second: This blog does occasional health stuff. Someone needs to dig into this statin-dementia connection,and if necessary talk about what it would take to get off them. I damn near choked on my coffee this am when I read that!!

  9. Jesse

    I thought it was funny that they released the ‘news’ that a grand jury had been convened to investigate MF Global — in November.

    And they were issuing subpoenas for the CME fellows who have already testified.

    Pure theater.

    1. Up the Ante

      Has anyone seen any explanation why this clown, Edith O’Brien, was refusing to meet with investigators ?

      ” MF Global: Treasurer Edith O’Brien, who is a “person of interest” and is key to the ongoing search for the missing client money, is allegedly refusing to meet with the investigators. She has asked for immunity from prosecution, according to The New York Times. O’Brien has frequently testified as an expert in the protection of customer funds at futures firms at the Commodities Futures Trading Commission. ”

      http://www.theblaze.com/stories/morning-market-roundup-apple-ceo%E2%80%99s-millions-mf-global-asks-for-immunity/

    2. Up the Ante

      Do the actions described in this piece speak of competence ?,

      http://www.valuewalk.com/2012/02/mf-global-investigators-focusing-on-325-million-transfer/

      “.. the cash in overseas customer accounts remains missing. ”

      “On the morning of Oct. 28, according to people familiar with the matter, Ms. O’Brien received a call from Mr. Corzine, who asked her to resolve a problem: ”

      http://www.fins.com/Finance/Articles/SBB0001424052970203960804577239861536790088/Investigators-Focusing-on-Money-Transfers-at-MF-Global

  10. Susan the other

    I can’t imagine Romney or Santorum speaking one word about this stuff. And if they did there would be a brief blackout of your TV, just like they did with Paul Volker when he got too chatty on Charlie Rose.

  11. psmith

    Such a change from the 1930s, when Nancy Mitford wrote Christmas Pudding. In that novel the character Jerome Field says: “The worst part of getting old these days seems to be that those of one’s friends who are neither dead, dying nor bankrupt, are in prison. It is really most depressing, one never knows when one’s own turn may not be coming. I said to my directors only today, ‘Now mind, if I go to the Old Bailey I don’t intend to stand in the dock alone. I asked all of you to be directors on the distinct understanding that you know as well as I do how to add, subtract and even multiply, and I count on you to be equally responsible with me for any slips that are made.’ That shook ‘em, I can tell you, especially that fat old fool, Leamington Spa; he practically asked me how long we could expect to be at large.”

  12. Anonymous Comment

    From a neutral point of view, I would apply the same line of reasoning to all participants in these on-going fiascos: Were they not sophisticated players? Who wrote the sophisticated-player clauses into the contracts? Was this particular individual not considered the penultimate of sophistication, the pinnacle of savvy?

    Why is it so easy for people to believe that these guys were incompetent now that jig is up? But no way were those on the signing end of these contracts incompetent. ‘No siree, they weer sophisticated folk. They even agreed so under penulty of perjeery.’

    If we had/have a system led at the summits of power and prestige by so many so-called-sophisticated, yet incompetent people, what does that say about our standards as a culture for recognizing competence and its opposite. Some kinds of ‘sophistication’ seem to cause anti-competence to those who are thought to possess it.

    Anyway, I’m sure it’ll work out fine for the guy. Peace.

    1. Comment

      Correction: the question is not ‘who wrote the clauses’, the question is who decided to use them as justification for ‘acting stupid’?

  13. Mattski

    Decades of criminal corporate malfeasance in which neoliberal governments have invested literally and figuratively, with losses being recouped through austerity programs–always with a rhetoric of necessary discipline–from the middle class and poor. A century’s worth of workers’ gains, obtained by unions and in the nation’s streets, often with blood, largely swept away.

    Seems like the kids rioting in Barcelona and Velencia today kinda get that. In Latin America they get it, and are in the complex business of repudiating it with new institutions like CELAC that may finally leave the US in ye olde dustbin. What percentage of people in the US, does anyone reckon, have the slightest clue?

    1. ECON

      Mattski you are soooo right! Despite our daily lives of business, a democracy requires a citizenry to be mindful of national governance and an independent media to inform and educate the citizen of their governance. Too many Americans are “entertained to death” in their daily lives and cannot discern talking points from the facts.

        1. psychohistorian

          Have you noticed that the country with the biggest military, most number of nukes and as the holder of Reserve Currency status is blowing this huge financial bubble on the backs of the worlds public?

          If Americans don’t rise up and reclaim their secular republic from the global inherited rich that currently run our fascist government as a ruthless imperialistic machine, we deserve to be taken down by those of our species that see clearly what the damage of class based rule delivers.

          Maybe when the nuke phase starts (if Fukushima doesn’t get us first), Americans will break away from their TV’s long enough to understand they have a social organization problem.

  14. ridovem

    In the play that’s currently forming in my frontal lobe, John Corzine is in the dock, found guilty for misappropriating (or schnizzling off) a billion USD and is the new Jesus who will now be imprisoned as a surrogate for a parade of the incarcerati, who make their way through the court, state their crime, it’s monetary value, and their sentence. They are absolved- free men & women- as they pass… and Corzine absorbs their collective jail time until the billion is accounted for. He has a brief soliloquy and goes off in irons to begin serving his 8,127 years at hard labor… meaning that he’ll have to keep the books for the prison dispensary. ^..^

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